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Answer to MTP_Final_Syllabus 2016_Jun2017_Set 2

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 1

Paper 20 - Strategic Performance Management & Business Valuation



Paper 20 - Strategic Performance Management & Business Valuation

Full Marks: 100 Time allowed: 3 hours

The figures in the margin on the right side indicate full marks.

Working notes should form part of the answer.

Section - A

Answer Question No. 1 which is compulsory and any two from the rest of this section

1. Multiple choice questions: [5×2=10]

[1 mark for right choice and 1 mark for justification]

(i) The components of the Stewart Cycle or PDCA are:

(A) Plan-Do-Check-Act

(B) Plan-Define-Check-Act

(C) Plan-Do-Control-Act

(D) Program-Do-Check-Act

(ii) The risk which is concerned with the general economic climate (such as growth rate of

income, characteristics of the labour force, level of foreign debt outstanding etc.) within

the country, is termed as:

(A) Country Risk

(B) Political Risk

(C) Economic Risk

(D) Social Risk

(iii) Which of the following is not the element/ parameter of NCAER model of corporate

distress prediction?

(A) Net worth position

(B) Outstanding liability position

(C) Net working capital position

(D) Cash profit position

(iv) The Average Cost of a firm is given by the function Average Cost = x3 + 12x² – 11x, its

marginal cost will be:

(A) 4x3 + 36x2 – 22x

(B) x4 + 12x3 – 11x2

(C) x3 + 12x2 – 11x

(D) None of the above

(v) The type of benchmarking, which is concerned with the development of core

competencies that will help sustained competitive advantage, is called:

(A) Global Benchmarking (B) Strategic Benchmarking (C) Internal Benchmarking (D) Competitive Benchmarking

Answer:

(i) (A) The components of Shewhart Cycle or PDCA or Deming Cycle or Deming wheel are

Plan, Do, Check and Act.

(ii) (C) Economic risk is concerned with the general economic climate within the country.

Some of the factors which reflect the economic climate of a country are: the growth

rate of income, characteristics of the labour force, level of foreign debt outstanding

etc.



(iii) (B) The NCAER Study on Corporate Distress Prediction prescribed three elements/

parameters for predicting the stages of corporate sickness, such as: (i) Cash profit

position (a profitability measure) (ii) Net working capital position (a liquidity measure)

and (iii) Net worth position (a solvency measure).

(iv) (A) Average Cost = x3 + 12x2 – 11x

Total Cost (C) = x4 + 12x3 – 11x2

3 2dcMarginal Cost = 4x +36x -22x

dx

(v) (B) Strategic Benchmarking helps to develop a vision of the changed organizations. It will

develop core competencies that will help sustained competitive advantage.

2. (a) What do you understand by Financial Performance Analysis? State the areas/

perspectives of it to measure the financial health. Also state the significance of the

Financial Performance Analysis. [3+3+4]

Answer:

Financial performance analysis:

Financial performance analysis is the process of identifying the financial strengths and

weaknesses of the firm by properly establishing the relationship between the items of

balance sheet and profit and loss account. It also helps in short-term and long term

forecasting and growth can be identified with the help of financial performance analysis.

The analysis of financial statement is a process of evaluating the relationship between the

component parts of financial statement to obtain a better understanding of the firm’s

position and performance. This analysis can be undertaken by management of the firm or by

parties outside the firm namely, owners, creditors, investors.

In short, the firm itself as well as various interested groups such as managers, shareholders,

creditors, tax authorities, and others seeks answers to the following important questions:

1. What is the financial position of the firm at a given point of time?

2. How is the Financial Performance of the firm over a given period of time?

These questions can be answered with the help of financial analysis of a firm. Financial

analysis involves the use of financial statements. A financial statement is an organized

collection of data according to logical and consistent accounting procedures.

The areas/ perspectives of Financial Performance Analysis to measure the financial health:

Financial analysts often assess firm’s production and productivity performance, profitability

performance, liquidity performance, working capital performance, fixed assets performance,

fund flow performance and social performance. Financial health is measured from the

following perspectives:

1. Working capital Analysis

2. Financial structure Analysis

3. Activity Analysis

4. Profitability Analysis

Significance of Financial Performance Analysis:

Interest of various related groups is affected by the financial performance of a firm.

Therefore, these groups analyze the financial performance of the firm. The type of analysis

varies according to the specific interest of the party involved.

Trade creditors: interested in the liquidity of the firm (appraisal of firm’s liquidity)



Bond holders: interested in the cash-flow ability of the firm (appraisal of firm’s capital

structure, the major sources and uses of funds, profitability over time, and projection of future

profitability)

Investors: interested in present and expected future earnings as well as stability of these

earnings (appraisal of firm’s profitability and financial condition)

Management: interested in internal control, better financial condition and better

performance (appraisal of firm’s present financial condition, evaluation of opportunities in

relation to this current position, return on investment provided by various assets of the

company, etc).

(b) “The Balanced Score Card (BSC) translates an organization’s mission and strategy into a

comprehensive set of performance measures that provides the framework for

implementing its strategy.” — State the steps in developing Balanced Score Card (BSC) in

this context. Mention the information required for Performance Measurement under BSC

and also states any three benefits of BSC. [3+4+3]

Answer:

The Balanced Score Card (BSC) translates an organization’s mission and strategy into a

comprehensive set of performance measures that provides the framework for implementing

its strategy.

Steps in developing Balanced Score Card (BSC):

The steps in the process of developing a BSC are:

- Identify the key outcomes to the success of the organization.

- Identify the process that leads to these outcomes.

- Develop key performance indicators for these processes.

- Develop reliable data capture and measurement systems.

- Develop a mechanism for reporting these to the relevant managers and staff.

- Enact improvement programs to ensure that performance improves.

Information required for Performance Measurement under Balanced Score Card (BSC):

The main types of information required by the managers to implement the balanced

scorecard approach to performance measurement are:

Customer Perspective - How do customer see us? - Price, quality, delivery, customer support

etc.

Internal Perspective- Where we must excel at? - Efficiency of manufacturing process, sales

penetration, new production introduction, skilled manpower etc.

Learning and Growth Perspective - Can we continue to improve and create value? -

Technology leadership, cost leadership, market leadership, research and development, cost

reduction, etc.

Financial Perspective - How do we look to the shareholders? - Sales, cost of sales, return on

capital employed, profitability, prosperity etc.

Benefits of BSC:

An organization can derive the following benefits by implementation of BSC:

o It avoids management reliance on short-term financial measures.

o It can successfully communicate corporate strategy to the functional heads and

organization’s subunits and forcing them to develop their own goals to achieve the

corporate mission and goals.

o It can assist stakeholders in evaluating the firm, if measures are communicated

externally.

o It helps in focusing the whole organization on the few key things needed to create

breakthrough performance.



o It helps to integrate various corporate programs like re-engineering, customer service

initiatives.

o It breaks down strategic measures towards lower levels, so that unit managers,

operators and employees can see what is required at their level to achieve excellent

overall performance.

o It helps in clarifying and updating budgets.

o It helps in identifying and aligning strategic initiatives.

o It helps in conduct of periodic performance reviews to learn about and improve

strategy.

3. (a) The total cost (C) and the total revenue (R) of a firm are given C (x) = x3 + 60x² + 8x;

R(x) = 3x3 - 3x² + 656x, x being output, determine the output for which the firm gets

maximum profit. Also obtain the maximum profit. [7+3]

Answer:

C = x3 + 60x2 + 8x

R = 3x3 – 3x2 + 656x

Profit = 3x3 – 3x2 + 656x – x3 – 60x2 – 8x

= 2x3 – 63x2 + 648x = (p)

Derivative w.r.to x

2dp6x 126x 648 0

dx

x2 – 21x + 108 = 0

x2 – 9x – 12x + 108 = 0

x(x – 9) – 12 (x – 9) = 0

(x – 12) (x – 9) = 0

x = 12 or 9 2

2

d p2x 21

dx

At x = 9 2

2

d p18 21 3 0

dx

Therefore, P is maximum at x = 9

At x = 12 2

2

d p24 21 3 0

dx

P is minimum at x = 12

P = 2x3 – 63x2 + 648x

At x = 9

Profit P = 2(9)3 – 63(9)2 + 648(9)

7292 – 63 x 81 – 648 x 9 = 2187.

(b) From the information given below relating to Unfortunate Ltd., calculate Altman’s Z-score

and comment:



Working capital= 0.45

Total assets

Retained earnings= 0.25

Total assets

Earnings before interest & taxes= 0.30

Total assets

Market value of equity= 2.50

Book value of total debt

Sales

Total= 3 times

assets

[10]

Answer:

As per Altman’s Model (1968) of Corporate Distress Prediction:

Z= 1.2 X1 +1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5

Here, the five variables are as follows:

X1 = Working Capital to Total Assets = 0.45

X2 = Retained Earnings to Total Assets = 0.25

X3 = EBIT to Total Assets = 0.30

X4 = Market Value of Equity Shares to Book Value of Total Debt= 2.50

X5 = Sales to Total Assets = 3 times

Hence, Z-score = (1.2 x 0.45) + (1.4 x 0.25) + (3.3 x 0.30) + (0.6 x 2.50) + (1 x 3)

= 0.54 + 0.35 + 0.99 + 1.50 + 3 = 6.38

Note: As the calculated value of Z-score is much higher than 2.99, it can be strongly

predicted that the company is a non-bankrupt company (i.e., non-failed company).

4. (a) “To be effective, any Enterprise Risk Management (ERM) implementations should be

integrated with strategy-setting”. Do you agree? Give your views bringing out the

basic elements of ERM and the reasons why ERM is implemented. [1+4+5]

Answer:

“To be effective, any Enterprise Risk Management (ERM) implementations should be

integrated with strategy-setting”. To my mind, this statement is true.

In today’s challenging business environment, opportunities and risks are constantly changing,

giving rise to the need for identifying, assessing, managing and monitoring the organization’s

business opportunities and risks. This, in turn, necessitates establishing the linkage between

the opportunities and risk while managing the business. This requirement is addressed by

ERM, which redefines the value proposition of risk management by elevating its focus from

the ‘tactical’ to the ‘strategic’. ERM is about designing and implementing capabilities for

managing the risks that matter. In the light of this, the statement is correct and therefore

acceptable.

Basic Elements of ERM:

The following are the basic element of ERM;

(i) A process, ongoing and flowing through an entity.

(ii) Effected by people at every level of an organization.

(iii) Applied in strategy setting.



(iv) Applied across the enterprise, at every level and unit and includes taking an entry-level

view of risk.

(v) Designed to identify potential events affecting the entity and manage risk within the risk

appetite

(vi) Able to provide reasonable assurance to an entity’s management.

(vii) Geared to the achievement of objectives in one or more separate but overlapping

categories. It is a means to an end, not an end in itself.

Need for Implementation of ERM:

ERM needs to be implemented for the following reasons:

(i) Reduce unacceptable performance variability.

(ii) Align and integrate varying views of risk management

(iii) Build confidence of investment community and stakeholders,

(iv) Enhance corporate governance.

(v) Successfully respond to a changing business environment

(vi) Align strategy and corporate culture.

Traditional risk management approaches are focused on protecting the tangible assets

reported on a company’s Balance Sheet and the related contractual rights and obligations.

The emphasis of ERM, however, is on enhancing business strategy. The scope and

application of ERM is much broader than protecting physical and financial assets. With an

ERM approach, the scope of risk management is enterprise-wide and the application of risk

management is targeted to enhancing as well as protecting the unique combination of

tangible and intangible assets comprising the organization’s business model.

(b) Write short note on:

(i) MOLAP

(ii) ROLAP [5+5]

Answer:

(i) MOLAP (Multidimensional On-Line Analytical Processing:

MOLAP is a “multi-dimensional online analytical processing”.’MOLAP’ is the ‘classic’ form of

OLAP and is sometimes referred to as just OLAP. MOLAP stores this data in an optimized multi-

dimensional array storage, rather than in a relational database. Therefore it requires the pre-

computation and storage of information in the cube - the operation known as processing.

MOLAP tools generally utilize a pre- calculated data set referred to as a data cube. The data

cube contains all the possible answers to a given range of questions. MOLAP tools have a

very fast response time and the ability to quickly write back data into the data set.

(ii) ROLAP (Relational On-Line Analytical Processing):

ROLAP works directly with relational databases. The base data and the dimension tables are

stored as relational tables and new tables are created to hold the aggregated information.

Depends on a specialized schema design. This methodology relies on manipulating the data

stored in the relational database to give the appearance of traditional OLAP’s slicing and

dicing functionality. In essence, each action of slicing and dicing is equivalent to adding a

“WHERE” clause in the SQL statement. ROLAP tools do not use pre-calculated data cubes

but instead pose the query to the standard relational database and its tables in order to

bring back the data required to answer the question. ROLAP tools feature the ability to ask

any question because the methodology does not limit to the contents of a cube. ROLAP also

has the ability to drill down to the lowest level of detail in the database.

Section - B

Answer Question No. 5 which is compulsory and any two from the rest of this section

5. Multiple choice questions: [5×2=10]



[1 mark for right choice and 1 mark for working]

(i) The following details are given for a company:

Sales - ` 1,00,000; Costs - `75,000; Depreciation - `20,000; Tax - 35%; Change in Net

Working Capital - ` 1,000; Change in Capital Spending - ` 10,000

Then the Free Cash Flow to Firm (FCFF) will be:

(A) `3,250

(B) `6,750

(C) `10250

(D) `12,250

(ii) Burnpur Cements Ltd. earned free cash flow to Equity Shareholders during the

Financial Year ending 2016 at ` 4.5 lakhs and its cost of equity is 13% with a projected

earnings growth rate of 10%. The market value of debt is ` 50 lakhs. The value of firm

as per Constant Growth Valuation Model will be:

(A) `45,00,000

(B) `1,45,000

(C) `1,50,000

(D) `1,65,000

(iii) A Ltd. is considering the acquisition of B Ltd. with stock. Relevant financial information

is given below.

Particulars A Ltd. B Ltd.

Present earnings `7.5 lakhs `2.5 lakhs

Equity (No. of shares) 4.0 lakhs 2.0 lakhs

EPS `1.875 `1.25

P/E ratio 10 5

The market capitalization of A Ltd. will be:

(A) `12.5 Lakhs

(B) `18.75 Lakhs

(C) `75 Lakhs

(D) `82 Lakhs

(iv) The risk-free rate = 5.5% The market price of risk = 7% The company’s beta = 1.2, then

Cost of equity will be?

(A) 12.5%

(B) 13.6%

(C) 13.7%

(D) 13.9%

(v) The Capital Structure of M/s XYZ Ltd., on 31st March, 2016 was as follows:

`

Equity Capital (18,000 Shares of `100 each) 18,00,000

12% Preference Capital 5,000 Shares of `100 each 5,00,000

12% Secured Debentures 5,00,000

Reserves 5,00,000

Profit earned before Interest and Taxes during the year 7,20,000

Tax Rate 40%

Calculate the Interest and Fixed Dividend Coverage:

(A) 3.8 Times

(B) 6.5 Times



(C) 7.6 Times

(D) 13 Times

Answer:

(ii) (D) `12,250

Sales - Costs - Depreciation `5,000

Less: Tax `1,750

PAT `3,250

Add: Depreciation `20,000

Less: Change in Net Working Capital `1,000

Less: Change in Capital Spending `10,000

Free Cash Flow to Firm (FCFF) `12,250

(iii) (D) `1,65,000

According to the constant growth valuation model.

V0 = (FCFF)1 /(Ke-g)

Where FCFF1 = FCFF0(1+g)

V0 = 4,50,000 x 1.10/(0.13-0.10)

V0 = 495000/0.03

V0 = ` 1,65,00,000.

(iv) (C) `75 Lakhs

P/E = Market Price/ EPS. Therefore we have, Market price = P/E × EPS

A Ltd.’s Market Price = 10 × 1.875 = `18.75

Market Capitalization (same as market value or in short referred as market Cap)

= Number of outstanding shares × market Price

A Ltd.’s Market capitalization = 4.0 lakhs × `18.75 =`75 Lakhs

(v) (D) 13.9%

Cost of equity = 5.5% + 7% (1.2) = 13.9%

(vi) (A) 3.8 Times

Calculation of profit after tax (PAT) ` `

Profit before interest & tax (PBIT) 7,20,000

Less: Debenture interest (` 5,00,000 x 12/100) 60,000

Profit before tax (PBT) 6,60,000

Loss: Tax @ 40% 2,64,000

Profit after tax (PAT) 3,96,000

Calculation of Interest and Fixed Dividend Coverage

PAT + Debenture Interest

DebentureInterest + Preference Dividend

3,96,000 + 60,000

60,000 + 60,000



= 3.8 times

6. (a) Calculate the value of the intangible assets of X Ltd. considering the excess returns

earned by it, from the following information for the y. e. 31.03.2015. [6]

(i) Average PBT ` 6,300 Lakhs

(ii) Average year end tangible assets ` 35,000 Lakhs

(iii) Cost of equity of the company is 15%

(iv) Return on Assets (ROA) industry average is 12%

(v) Tax rate is 30%

Answer:

Average PBT ` 6300 lakhs

Average year end tangible assets `35000lakhs

ROA of the company 18% (6300 ÷ 35,000) x 100

Industry ROA 12%

Excess return = PBT - (12% x 3 5,000)

= 6300-4200 = 2100 lakhs

Premium attributable to intangible assets = (1-t) × Excess return

= (0.7) × 2100

= ` 1,470 lakhs

Value of intangibles = Premium attributable to Intangible Assets ÷ Company’s cost of

capital

= 1470 ÷ 0.15 = `9800 lakhs.

(b) ABC Ltd has FCFF of `170 Crores and FCFE of `130 Crores. ABC Ltd’s WACC is 13% and its

cost of equity is 15%. FCFF is expected to grow forever at 7% and FCFE is expected to

grow forever at 7.5%. ABC Ltd has debt outstanding at `1500 Crores. Find the value of

ABC Ltd using FCFF approach and FCFE approach. [6]

Answer:

FCFF Approach: (discount rate = WACC) The firm value is the present value of FCFF discounted at the weighted-average cost of

capital (WACC):

= FCFFt /(k-g) = 170 x 1.07 / (0.13 - 0.07) = `3031.67 Crores

The market value of equity is the value of the firm minus the value of debt:

Equity = 3031.67 - 1500 = `1531.67 Crores

FCFE Approach: (discount rate = Cost of Equity) Using the FCFE valuation approach, the present value of FCFE, discounted at Cost of

equity

= FCFEt/(k-g) = 130 x 1.075/(0.15 - 0.075) = `1863.33 Crores

(c) From the following extracts of financial data pertaining to HS Ltd., an IT company, you are

required to calculate the value of the brand of the company:



Year ended on 31st march 2016 2015 2014

EBIT ` lakhs 750 525 280

Non-branded income ` lakhs 60 45 15

Inflation (%) 8 15 11

Remuneration of capital 6% of Average Capital Employed

Average capital employed ` lakhs 1,450

Corporate tax rate 30%

Capitalization factor 15%

[8]

Answer:

HS Ltd

Calculation of Brand Value as at 31-3-2014 (` in lakhs)

Year ended on 31st March 2016 2015 2014

EBIT ` lakhs 750 525 280

Less Non-branded income ` lakhs 60 45 15

Adjusted profit ` lakhs 690 480 265

Inflation (%) 8 15 11

Inflation compound factor 1 1.08 1.242

PV of profit 690 518.4 329.13

Weight 3 2 1

Weighted Profits 2070 1036.8 329.13

Weighted Average profit 572.655 = 573

Remuneration of capital 6% of Average Capital Employed

Average Capital employed ` lakhs 1450

Remuneration of capital 87

Brand related profit 486

Corporate tax rate 30%

Corporate Tax 146

Brand Earning 340

Capitalization factor 15%

Brand Value ` lakhs 2,266.67

7. (a) R Ltd. is intending to acquire S Ltd. (by merger) and the following information is available

in respect of both the companies—

Particulars R Ltd. S Ltd.

Total current earnings ` 2,50,000 ` 90,000

Number of outstanding shares 50,000 30,000

Market price per share ` 21 ` 14

You are required to calculate—

(i) Present EPS of both the companies,

(ii) If the proposed merger takes place what would be the new EPS for R Ltd. (assuming

that merger takes place by exchange of equity shares and the exchange ratio is

based on the current market price)

(iii) What should be the exchange ratio if S Ltd., wants to ensure the same earnings to

members as before the merger took place? [12]

Answer:

(i) EPS = Total Earnings/No. of Equity shares

EPS R ltd = 2,50,000/50,000=` 5

EPS s ltd = 90,000/30,000=` 3

(ii) No. of shares S Ltd shareholders will get in R Ltd based on market prices of shares is as

follows:

Exchange Ratio = 14/21 =2/3 i.e. for every 3 shares of S Ltd 2 shares of R Ltd



Total No. of shares of R Ltd issued = 14/21×30,000=20,000 shares

Total number of shares of R Ltd after merger = 50,000+20,000=70,000

Total Earnings of R Ltd after merger = 2,50,000+90,000=3,40,000

[Remember no synergy given]

The new EPS of R Ltd after merger =` 3,40,000/70,000=` 4.86.

(iii) Calculation of Exchange Ratio to ensure S Ltd to earn the same before the merger took

place: Both acquiring and acquired firm can maintain their EPS only if the merger takes

place based on respective EPS.

Exchange Ratio based on EPS=3/5=0.6

Total Shares of R Ltd receivable by S Ltd. shareholders=0.6×30,000=18,000

Total number of shares of R Ltd after merger = 50,000+18,000=68,000

EPS after merger = Total Earnings/Total number of shares = [` 2,50,000+` 90,000] /68,000

=` 5.

Total Earnings after merger of S Ltd = ` 5×18,000=` 90,000.

(b) Kolkata Ltd and Mumbai Ltd have agreed that Kolkata Ltd will take over the business of

Mumbai Ltd with effect from 31st December 2013. It is agreed that:

(i) 10,00,000 shareholders of Mumbai Ltd will receive Shares of Kolkata Ltd. The Swap

ratio is determined on the basis of 26 week average market prices of Shares of both

the Companies. Average Prices have been worked out at `50 and `25 for the shares

of Kolkata Ltd and Mumbai Ltd respectively.

(ii) In addition to (i) above, the shareholders of Mumbai Ltd will be paid in cash based on

the projected synergy that will arise on the absorption of the business of Mumbai Ltd

by Kolkata Ltd. 50% of the projected benefits will be paid to the share holders of

Mumbai Ltd.

The following projections have been agreed upon by the management of both the

Companies.

Year 2014 2015 2016 2017 2018

Benefit (in ` Lakhs) 50 75 90 100 105

The benefit is estimated to grow at the rate of 2% from 2018 onwards. It has been

further agreed that a discount rate of 20% should be used to calculate the cash that

the holders of each share of Mumbai Ltd will receive.

(vii)Calculate the cash that holder of each share of Mumbai Ltd will receive.

(viii) Calculate the total purchase consideration.

(Discounting Rate 20%: 1 year-0.833, 2 year – 0.694, 3 year – 0.579, 4 year – 0.482, 5

year -0.402, 6 year - 0.335) [4+4]

Answer:

(i) Present Value of Synergy Benefits

Synergy Benefits Year Computation PV= `Lakhs

2014 50 × 0.833 41.65

2015 75 × 0.694 52.05

2016 90 × 0.579 52.11

2017 100 × 0.482 48.20

2018 105 × 0.402 42.21

2019 onwards (Terminal value

Note)

(105 × 102% ÷18%) × 0.402 239.19



Total 475.41

50% on the Synergy Benefits = 475.41 × 50% = `237.705 Lakhs

Cash for every share held in Mumbai Ltd = 237.705 ÷ 10 = `23.77

(ii) Total Purchase Consideration for the business

(a) Equity share (25/50 × 10,00,000 × `50) `250.00 Lakhs

(b) Cash = 50% of Synergy Benefits `237.70 Lakhs

Total `487.70 Lakhs

8. (a) The Shareholders of A Co. have voted in favor of a buyout offer from B Co. Information

about each firm is given here below. Moreover, A Co.’s shareholders will receive one

share of B Co. Stock for every three shares they hold in A Co.

Particulars (amount in Rupees) B Co. A Co.

Present earnings 6.75 lakhs 3.00 lakhs

EPS 3.97 5.00

Number of Share 1.70 lakhs 0.60 lakhs

P/E ratio 20 5

(i) What will the EPS of B. Co. be after the merger? What will the PE ratio be if the NPV of the

acquisition is zero?

(ii) What must B Co. feel is the value of the synergy between these two firms?

Explain how your answer can be reconciled with the decision to go ahead with the

takeover. [5+5]

Answer:

(i) The EPS of the combined company will be the sum of the earnings of both companies

divided by the shares in the combined company. Since the stock offer is one share of

the acquiring firm for three shares of the target firm, new shares in the acquiring firm

will increase by one- third [ Exchange ratio = 1/3].

So, the new EPS will be: EPS = (`300,000 + 675,000)/[170,000 + (1/3) (60,000)] = `5.132.

The market price of B Co. will remain unchanged if it is a zero NPV acquisition.

Using the PE ratio, we find the current market price of B Co. stock, which is

= P/E x EPS

= 20 x (6.75 lakhs/ 1.70 lakhs) = `79.41

If the acquisition has a zero NPV, the stock price should remain unchanged. Therefore, the

new PE will be: P/E = `79.41 / `5.132 = 15.48

(ii) If the NPV of the acquisition is zero, it would mean that B Co. would pay just the market

value of A Co. i.e. Number of shares x market price of A Co. i.e. = 60000 x 25 [MPS = P/E x

EPS = 5 x5 = 25]. The market value received by B co. = `15,00,000.

The cost of the acquisition is the number of shares offered times the share price, so the

cost is: Cost = (1/3) (60,000) (`79.4118) = ` 15,88,236.



The difference is synergy i.e. ` 88,236.

(b) Following is the information collected for a company, provided to you:

BALANCE SHEET OF XYZ LTD AS AT 31st MARCH ……………………

(` in Crores)

Particular 2016

EQUITY AND LIABILITIES:

SHAREHOLDER'S FUNDS

Share capital

Reserves and Surplus

NON-CURRENT LIABILITIES

Long-term Borrowings

Deferred tax liabilities (Net)

Other long-term liabilities

Long-term provisions

CURRENT LIABILITIES

Trade payables

Other current liabilities

Short-term provisions

TOTAL

ASSETS

NON-CURRENT ASSETS

FIXED ASSETS:

Tangible assets

Capital work-in-progress

Intangible assets

Non-current investments

Long-term loans and advances

Other non-current assets

CURRENT ASSETS

Current investments

Inventories

Trade receivables

Cash and bank balances

Short-term loans and advances

TOTAL

36.37

2,225.66

2,262.03

6,322.76

39.39

7.09

355.03

6,724.27

1,797.88

12.24

19.00

1,829.11

10,815.41

4,535.68

898.83

550.00

5,984.51

1,664.30

891.97

3.03

2,559.30

142.50

1,389.92

585.77

38.41

115.00

2,271.60

10,815.41

STATEMENT OF PROFIT AND LOSS OF XYZ LTD. FOR THE YEAR ENDING ON 31st MARCH ….

(` in Crores)

Particulars 2016

Revenue from operations

Less: Excise Duty

Other Operating Income

Other Income

295.00

26.39 268.61

0.30

0.13 269.04



TOTAL Revenue

EXPENSES

Raw materials consumed

Power & Fuel Cost

Changes in inventories of finished goods, work-in-progress, and stock-in-

trade

Employee benefits expense

Depreciation and amortization expense

Interest cost

Other expenses

TOTAL expenses

132.79

21.37

(1.63)

5.97

20.77

32.19

34.23 245.69

PROFIT/(LOSS) BEFORE TAX AND EXTRA-ORDINARY ITEMS

Less: Extra-Ordinary items

23.35

0.64

PROFIT/(LOSS) BEFORE TAX

Tax Expenses

Tax paid @ 32.50%

Deferred Tax

PROFIT/(LOSS) AFTER TAX

22.71

7.38

1.37

8.75

13.96

If the Weighted Average Cost of Capital (WACC) is 15% then you are required to

calculate EVA for the year 2015-16. [10]

Answer:

EVA = NOPAT – Capital Employed x Cost of Capital

Profit /(Loss) Before Tax and Extra – ordinary items

Adjustments for ………………..

Add: Interest Cost

Less: Non –Operating Income

Operating Profit Before Tax

Less: Income Tax @ 32.50%

` 23.35

` 32.19

(` 0.13)

` 55.41

` 18.01

Net Operating Profit After Tax (NOPAT) ` 37.40

Calculation of Capital Employed:

Share Capital

Reserves and Surplus

Long – Term Borrowings

Other long term liabilities

Long term provisions

` 36.37

` 2,225.66

` 6,322.76

` 7.09

` 355.03

Capital Employed ` 8946.91

Net Operating Profit After Tax (NOPAT)

Less: The cost of Capital Employed (8,946.91 x 15%)

` 37.40

` 1,342.04

EVA ` (1,304.64)

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